W2 box 12 code Z

[snafu_101]

Hello,

My W2 for tax year 2023 has a code Z in box 12 indicating a section 409(A) violation. TurboTax (any edition) does not support the calculations needed to compute the penalty. Has anyone else experienced this, and have any pointers/references for how I should calculate the penalties? Any referrals to qualified tax professionals that would assist me with this (for a fee, of course)? All the local CPA's I contacted declined.

Thanks.

[DavidD66]

An amount reported in Box 12 of W-2 with code Z indicates a violation Section 409(A).  A section 409(A) violation results in substantial tax penalties for the employee, independent contractor, or director affected.  All of the tax penalties for violations are imposed on the service provider.  There are no penalties imposed on the company or organization making the payments; however, the payor has reporting requirements and employers have withholding requirements.

When there is a violation of Section 409(A), the non-qualified deferred compensation in question becomes fully taxable as soon as the service provider becomes vested.  In addition, there is a 20% tax penalty on the value of the non-qualified deferred compensation imposed at the time of vesting.

Since the 409(A) violation was reported on your W-2, your employer is responsible for both reporting and withholding.  Therefore, in addition to an amount reported in Box 12 with code Z of your W-2, that amount should be included in Box 1 of your W-2 as wages.   Federal Income tax should have been withheld at a rate of 25%, and 35% if on the amount of wages that exceed $1,000,000.  The 20% excise tax (penalty) is reported on line 17h of Schedule 2 (Form 1040).  Employers are not required to withhold for the excise tax (penalty).   

You can report this yourself using TurboTax Desktop software.  The desktop version of TurboTax has a "Forms" view which allows you to make entries directly on forms and schedules. You can also transfer your TurboTax Online return to TurboTax Desktop.  For instructions on how to do so see the following TurboTax help article:  How do I switch from TurboTax Online to TurboTax Desktop?

To report the 20% excise tax (penalty) in TurboTax Desktop:

• Enter your Form W-2
• Click on the "Forms" icon in the upper right hand portion of your screen
• Select "Form 1040" under Forms in My Return on the left side of your screen
• Scroll to line 23 - Other Taxes... and select it
• Click on the magnifying glass.  This will take you to Schedule 2 (Form 1040)
• On line 17h of Schedule 2, enter 20% of the amount reported in Box 12 of your W-2 with Code Z.
• The amount of your excise tax (penalty) will now appear/be included in line 23 of Form 1040.

[snafu_101]

Thank you @DavidD66 for your reply.

Let me add a few details about my situation:

1. I deferred part of my compensation in tax years 2017, 2018, and 2019. I expected to get three corresponding payments in later years.

2. I got payments in tax years 2022 and 2023 that were apparently correct.

3. In tax year 2023, the plan administrator discovered that the third payment should have been made in tax year 2020 ad was missed. They made the payment in tax year 2023 and issued the 2023 W2 with code Z in box 12 with the amount of the third (missed) payment.

Given the above:

1. Did the 409(A) violations occur in tax year 2020 or 2023?

2. Section 409(A) says all deferred income becomes immediately taxable on violation. Do I need recompute and re-file my taxes for 2017, 2018, and 2019, or even 2020? Or for the open tax years?

3. How about the premium interest tax mentioned in section 409(A)? Do I compute it for the years above?

4. Or did the violation only occur in 2023, all deferred income was already included in income, and so I should only do the 20% penalty for the third (missed) payment and perhaps the premium interest tax for year 2023?

Thanks a lot in advance!

[DavidD66]

Section 409(A) violations can be complicated, so this should not be construed to be expert advice.  I believe that even though the payment in question vested, and should have been made in 2020, since you did not have constructive receipt of the funds, it should be reported on your 2023 return, and not your 2020 return.  The payment is subject to interest from the date the payment should have been made.  The interest rate is the "underpayment" rate plus 1% on the underpayments that would have occurred had the amounts so required to be included in gross income.  To calculate the amount of interest, you will first need to determine the amount of the underpayment of tax in 2020 by recalculating your tax liability for that year as if the payment had been made.  

Depending on the amount of money involved, you might want to seek out a professional to help you.  Consult your state's society of CPAs.  Should you choose to do it yourself, you might consider contacting the IRS for guidance on how to calculate and report the interest.   

[karen]

I have done this for the situation but Turbo Tax Desktop still has an error which prevents electronic filing does it not?  

[MarilynG1]

Yes, since TurboTax does not support the calculations for Code Z in Box 12 of W-2, you will need to mail in your return.

@karen

[karen]

Thank you. I just paid for e-file for state...ugh. Calculating 20% on an amount isn't difficult. It's a shame that this one thing prevents a return from being filed electronically.